Treasury 5-Year Notes Lead Gains as Summers Drops From Fed Race

By Susanne Walker and Cordell Eddings -
Sep 16, 2013

Treasury notes rose on speculation the withdrawal of Lawrence Summers’s candidacy to become the next Federal Reserve chairman may mean the central bank will be less aggressive in slowing monetary stimulus.

Five-year notes led gains on speculation Vice Chairman Janet Yellen would likely hold short-term rates lower for longer if she succeeds Ben S. Bernanke in January. Yields fell as much as 14 basis points before price gains were more than cut in half. The yield on the 30-year bond rose, after touching a more than one-week low, with Federal Open Market Committee members forecast to announce a tapering of the central bank’s bond-buying program at a two-day policy meeting that begins tomorrow.

“This is a relief rally,” said Thomas di Galoma, head of U.S. rates sales at ED&F Man Capital Markets in New York. “There was such a fear that Summers could be so much more hawkish than Yellen.”

The U.S. 5-year yield fell seven basis points, or 0.07 percentage point, to 1.62 percent at 4:59 p.m. New York time, according to Bloomberg Bond Trader prices. The 1.5 percent note due in August 2018 rose 11/32, or $3.44 per $1,000 face amount, to 99 13/32. The yield dropped as low as 1.55 percent, the lowest since Aug. 28.

The yield on the benchmark 10-year note dropped two basis points to 2.86 percent, after falling as much as 11 basis points. Thirty-year bond yields rose three basis points to 3.87 percent, after touching 3.78 percent.

‘Too Aggressive’

Treasury trading volume at ICAP Plc, the largest inter-dealer broker of U.S. government debt, rose 48 percent to $418 billion, from $282 billion on Sept. 13. The 2013 average is $316 billion.

Volatility in Treasuries as measured by the Bank of America Merrill Lynch MOVE index dropped 1.7 percent to 94.55, the lowest level since Aug. 15. It climbed on Sept. 5 to 114.19, a two-month high. The 2013 average is 71.56.

“The FOMC meeting and the uncertainty around the tapering story is still the story of the week, and is whipping the market around,” said Aaron Kohli, an interest-rate strategist in New York at BNP Paribas SA, one of 21 primary dealers that trade with the Fed. “We are also seeing a fade of the Summer’s move, which is keeping shorter-dated debt stronger, as the market was too aggressive in pricing in what the lack of a Summer’s nomination means.”

More than 50 percent of investors expect little reaction in Treasuries if tapering starts this week, suggesting it’s largely priced in, Guillermo Felices, head of asset allocation at Barclays Plc, a primary dealer, wrote in client note, based on a survey of close to 800 global investors.

Annual Loss

About 64 percent expect tapering will start this week, and almost all respondents expect it will occur before year-end, Felices wrote. Meanwhile, 45 percent expect the Fed to finish its open-ended stimulus program in the second quarter of 2014,.

Treasuries have lost investors 3.8 percent this year through Sept. 13, exceeding the biggest annual declines recorded in Bank of America Merrill Lynch data that go back to 1978.

While speculation the Fed will reduce its bond purchases as soon as this week has left investors with losses, JPMorgan Chase & Co. financial models show the end to the central bank’s zero-rate policy would have an even bigger impact.

JPMorgan’s model shows the end of all Fed bond buying would lift 10-year note yields by 25 basis points, which the firm says is already priced into the market. If the Fed’s forward guidance was ended, meaning the timing of the first benchmark rate increase was moved forward to today, it would lift yields by 45 basis points, the model indicates.

Taper Survey

The Fed cut its target for overnight bank lending to a range of zero to 0.25 percent in December 2008 as the financial crisis mounted, and has vowed to keep it there until the economy and employment show sustained signs of recovery.

Fed funds futures show a 29 percent probability that the central bank will raise rates higher than the current zero and 0.25 percent range, at the September meeting in 2014.

Yellen has been mentioned by U.S. President Barack Obama as a candidate for the chairman role.

Policy makers are buying $85 billion a month of Treasuries and mortgage bonds to put downward pressure on long-term borrowing costs and strengthen the economy. The central bank today purchased $927 million in Treasuries maturing from November 2024 to February 2031, according to the Fed’s Website. The Fed will decide to slow purchases to $75 billion at a two-day meeting starting tomorrow, according to a Bloomberg News survey of economists on Sept. 6.

Empire Drops

Treasuries remained higher as the Federal Reserve Bank of New York’s general economic index eased to 6.3 from 8.2 last month, lower than forecast. The median projection in a Bloomberg survey of economists called for a reading of 9.1. A measure of the six-month outlook climbed to the highest since April 2012. Readings greater than zero signal expansion in New York, northern New Jersey and southern Connecticut.

The additional yield investors receive for holding 30-year bonds over their five-year equivalents increased 10 basis points to 224 basis points, the most since Aug. 22.